Why Michael Kors' Shares Are in the Doghouse

This story has been updated from 11:16 am ET with additional information in the fourth and fifth paragraph.

NEW YORK (TheStreet) - Michael Kors (KORS) shares are in the doghouse with investors, as analysts voiced concerns over the fashion accessory retailer's profitability going forward.

The analysts' notes come following news on Monday in which The Wall Street Journal noted that the Hong Kong-based retailer known for its "jet set" fashion goods should take a lesson or two from its competitor, Coach (COH), specifically it was a word of caution against over-expansion. Shares dropped 7.7% to $79.08 on Tuesday -- a level not seen since early February.

Shares have fallen approximately 13% since it reported its fiscal fourth quarter earnings on May 28.

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On Tuesday, a flurry of analysts voiced caution over Michael Kors. Maxim Group analyst Rick Snyder downgraded shares to "hold" from "buy" and his 12-month price target by $24 to $85. Snyder cited concerns that "domestic sales have weakened to a greater degree than anticipate," according to the research note.

"Our checks indicate that this has led to increased markdown activity, which is likely to pressure gross margin," Snyder wrote. "We believe that current concerns over Michael Kors' gross margin will lead to multiple contraction as investors lose confidence in their near-term growth prospects."

Sterne Agee analyst Ike Boruchow, who rates shares "neutral," also sounded the alarm. He says that while sales growth at the retailer is still "in flight," he too worries that margins could be "nearing the end of the runway," according to a note on Tuesday. Boruchow cut his 12-month price target by $8 to $92, and lowered his fiscal 2015 estimates by 5 cents to $3.95 a share and fiscal 2016 earnings estimates by 15 cents to $4.55 a share.

"Investor sentiment has shifted significantly post Q4 results, with questions increasingly focused on the trajectory of top line, as well as sustainability of margins," Boruchow penned in a note to clients on Tuesday. "While sales growth is likely to remain strong in the near term, our recent store work has found broader/deeper markdowns within retail stores and key wholesale accounts. Whether these 'red flags' are a tipping point in profitability remains to be seen; that said, we recommend remaining sidelined until we gain greater visibility."

Boruchow continued: "Elevated inventory levels, broader discounting, and investment needs may all combine to pressure margins in the near future, and as a result, we believe it will be difficult for the stock to outperform materially despite solid top-line trends."

Citigroup analyst Oliver Chen slashed his 12-month price target on the company by $19 to $98 on Tuesday. Chen, who rates Kors "neutral," is worried the stock could be "range bound" over the near term, based on the answers to a survey Citi completed that had 62 respondents. Concerns include: "additional commentary on lack of newness and limited selection; elevated clearance levels in full price stores (30-50% off promotion for 30% of thestore); a risk of moderating store productivity levels given notable store expansion cadence," according to the note.

While sales trends were "strong" in April and May, according to Chen, up +15.15% and +13.71% respectively, sales growth slowed to +7.8% in June. Chen tweaked his full-year earnings estimates lower by 5 cents to $3.95.

Michael Kors reports its fiscal first-quarter results on August 5. Analysts, according to Thomson Reuters expect the company to post earnings of 81 cents a share for the quarter, up 34%, on $853 million of revenue, up 33% from last year. For the full year, analyst expect the company to earn $3.97 a share on revenue of $4.204 billion, an increase of 27% year over year.

Unlike its competitor Coach, Michael Kors still has "significant top-line momentum" at the moment, Sterne Agee's Boruchow wrote.

"The company has been a major beneficiary of COH's struggles, with significant (and accelerating) market share gains over the past 12 months. Though U.S. sales growth has moderated somewhat and is likely to continue moderating over time, the company's domestic comps remain among the best in retail today (we model a 17% U.S. comp for Q1), and we may see persistently solid top-line results from KORS over the coming quarter," the analyst wrote in the note.

The retailer's semi-annual sale appears to be broader than last year, Boruchow wrote, suggesting that the company cannot get rid of merchandise at full price, leaving it with excess inventory, which includes not only "slow sellers" and seasonal fashion bags but core products as well.

Michael Kors sells its merchandise through retail stores as well as through wholesale accounts like Macy's (M) and Nordstrom (JWN) and through licensing agreements. Boruchow noted that in the first quarter there were "far more markdowns" at its wholesale partners than last year.

Company management warned at the end of May that gross margin in the first quarter would be slightly lower than last year and that its operating expense rate would be slightly higher as its high growth. The company continues to invest in its brand by opening stores, particularly in Europe. Management gave first-quarter guidance between 78 cents and 80 cents a share.

"Although it is tough to critique a [quarter] with a 26% comp and 64% EPS growth, one thing to note is that [gross margin] was up only 20bps compared to increases of 100bps or more in prior [quarters]. This could be a sign that markdown levels are finally beginning to normalize," Wells Fargo Securities analyst Paul Lejuez wrote in May.

--Written by Laurie Kulikowski in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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